As previously mentioned, one way that a business combination can be accomplished is by the acquisition of net assets of the acquired company. From this point on in discussions related to business combinations focus on the acquisition of a controlling interest in a company (greater than 50%). The acquiring company is generally referred to as the parent; the acquired company is generally referred to as the subsidiary.
When a stock acquisition occurs, the parent company records the transaction in a single asset account, Investment in Subsidiary. The subsidiary is not a party to the transaction. Rather the stock is acquired from the stockholders of the subsidiary. Because of this, the subsidiary will continue to operate as a separate legal entity that prepares its financial statements in the same manner as took place before the acquisition. If the parent company, however, has obtained effective control over the subsidiary, the accounting principles require that parent company consolidate the subsidiary’s financial statements with its own. Basically what happens in the consolidation, is the replacing of the single asset account Investment in Subsidiary, with the underlying net assets, adjusted to fair market value at the date of acquisition. The resulting consolidated financial statements appear as those of a single economic entity.
Discussions from this point forward that deal with business combinations focus on the procedures whereby the subsidiary’s financial statements are consolidated with those of the parent. As a first step, the consolidation is assumed to occur at the date of acquisition. Later on, this assumption will be relaxed. For the time being, however, the foundation is laid based on consolidation at the date of acquisition. For more information on this, click here.